When in Peril, Retrench: Testing the Portfolio Channel of Contagion

Fernando Broner, R. Gaston Gelos () and Carmen Reinhart

No 10941, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: One plausible mechanism through which financial market shocks may propagate across countries is through the effect of past gains and losses on investors' risk aversion. The paper first presents a simple model examining how heterogeneous changes in investors' risk aversion affects portfolio decisions and stock prices. Second, the paper shows empirically that, when funds' returns are below average, they adjust their holdings toward the average (or benchmark) portfolio. In other words, they tend to sell the assets of countries in which they were "overweight", increasing their exposure to countries in which they were "underweight." Based on this insight, the paper discusses a matrix of financial interdependence reflecting the extent to which countries share overexposed funds. Comparing this measure to indices of trade or bank linkages indicates that our index can improve predictions about which countries are likely to be affected by contagion from crisis centers.

JEL-codes: F02 F30 F32 F36 (search for similar items in EconPapers)
Date: 2004-12
New Economics Papers: this item is included in nep-fin and nep-rmg
Note: IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (26)

Published as Broner, Fernando A., R. Gaston Gelos and Carmen M. Reinhart. "When In Peril, Retrench: Testing The Portfolio Channel Of Contagion," Journal of International Economics, 2006, v69(1,Jun), 203-230.
Published as Fernando Broner & Gaston Gelos & Carmen Reinhart, 2004. "When in peril, retrench: testing the portfolio channel of contagion," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.

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Related works:
Journal Article: When in peril, retrench: Testing the portfolio channel of contagion (2006)
Working Paper: When in Peril, Retrench: Testing the Portfolio Channel of Contagion (2005)
Working Paper: When in peril, retrench: Testing the portfolio channel of contagion (2005)
Journal Article: When in peril, retrench: testing the portfolio channel of contagion (2004)
Working Paper: When in peril, retrench: testing the portfolio channel of contagion (2004)
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